Populism and time inconsistency

Mario Blejer, Piroska Nagy-Mohacsi 22 November 2017

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Lately we have been witness to a myriad of anti-elite political movements and anti-establishment leaders gaining power or greatly strengthening their appeal and prospects. Many of these, from very different extractions, are being defined as ‘populists’. We do not attempt here to provide such a definition; rather we describe populist politicians from both the right and the left as those who cater to, or instigate, in words and in action, actual or perceived popular grievances without accounting for or caring about the costs and consequences of their proposed solutions. We thus consider populists in broadly defined democratic and semi-democratic systems, where voter preferences count. Totalitarian rulers and dictators do not have to cater to voters, so the question of populism does not arise.

In simple terms, populists are those who court election by promising to throw a ‘party’ for which they never intend to pay. They are aware of the costs of their policies, but their objective is to gain and maintain power irrespective of the costs. Since they don’t intend to pay for the consequences, they don’t restrain themselves. In the pursuit of their objectives they take advantage of democratic means but they eventually violate and even destroy democracies’ political, fiscal, and institutional constraints.

Time-inconsistent policymakers

To better understand how this could happen in well-functioning democratic societies, we have to recall the well-established fact that democratic societies and their mainstream (i.e. non-populist) policymakers often exhibit the problem of time inconsistency – that is, what is a ‘best plan’ today will not be optimal in some future period, and there is therefore a temptation to modify or cancel already-planned policies when that future period arrives. It is crucial to clarify the source of this time inconsistency. It mostly arises because the costs and benefits of policies and institutional changes appear at different times. In general, the benefits can be short-term and they can precede the costs. If left unattended, this intertemporal asymmetry gives raise to incentives that lead to suboptimal outcomes. Policy time inconsistency leads, for example, to higher inflation and unemployment. Such a result arises even when the players are mainstream non-populist politicians.

In the face of the high costs of the variety of irresponsible policies induced by time inconsistency, democracies have adopted commitment mechanisms to internalise time inconsistencies and revert the society and its politicians back to an optimal policy course for the longer term. These mechanisms include the establishment and the protection of independent institutions such as the judiciary, media, or central banks, and ultimately democratic elections. The mainstream politician, despite being time inconsistent, is assumed to have basic respect for governance rules and institutions. He is intuitively reluctant to blatantly violate institutional rules including property rights, or to default on legal obligations including debt. Under these assumptions, the protective mechanisms have provided a good degree of stability and gone a long way in solving the time inconsistency problem.

Time-consistent populist leaders

Enter now the populist leader. Contrary to the time-inconsistent but otherwise responsible mainstream politician, he himself is time-consistent regarding his objective. He pursues one single and unchanged objective – power – through the democratic cycles. He pursues policies to maximise his chances to remain in power, ultimately forever (dictatorship), regardless of their costs. Policies are secondary to his main objective.

The centrepiece of this tactic is to exploit as much as possible the ‘window of opportunity’ that gives rise to the time inconsistency in the first place – that is, the time gap between the upfront benefits of populist policies and the future economic and political/institutional cost of these policies. By skilfully maximising the political gains of today’s benefits while postponing dealing with the costs, he establishes himself, gains popularity, recruits staunch followers, and receives massive public support for his permanent disqualification of legitimate institutions.

The populist wants, of course, to complete his takeover of the system before the negative consequences of his policies start to bite. But if he cannot achieve this objective he ‘doubles up’, raising his populist bets. Policies that benefit his constituencies gain priority while deficits, inflation, debt, and/or state intervention, price control, and protectionism increase as democratic institutions crumble.[1] Again, the populist leader is ‘time consistent’ – he expected these results and never intended to pay for those costs, financed through the use of financial and physical repression, default, institutional destruction, expropriation, etc. He continues to promise massive gains in output, employment, trade, and so on, and when he finally fails to deliver, he finds someone else to blame for spoiling the party. He starts resorting to extreme policies (undue pressure on business leaders, state interventions in various forms, nationalisation, and so on) particularly before each election cycle. He also goes after individual freedoms, and institutions whose remit is to protect them.

The process takes at this point a dynamic that is difficult to arrest and reverse – the populist has changed the rules of democratic engagement that ensures necessary policy corrections, and has cemented his power. This also raises the question: How could a well-organised democratic society, even one where many citizens have grudges and complain, converge towards such a frightening outcome?

First, it is crucial to recognise, as recent research has increasingly shown, that in pursuing power, the populist also exploits some grievances that are justified. Examples can differ by country, level of development, democratic traditions, etc. Examples include long-term rising income inequality (e.g. Piketty 2014, Stiglitz 2015); cultural insecurities to social change and migration (James 2000, 2001); decline of the social status of white men and their life expectancy (Case and Deaton 2015); diminishing returns to globalisation while costs in terms of perceived job loss remain high (Rodrik 1997, 2017); and the failure of elites to assume their share of responsibility for economic crises.

Justified disenchantment with the elites and their institutions can be significant and particularly confusing when it comes to ways of dealing with the populist threat, as a recent paper by Guiso et al. (2017) highlights. The attraction of populism increases when the public develops doubts of the capability of elites and institutions to provide fair processes and outcomes. Institutional reforms proposed by mainstream politicians are hijacked by the populist leader who blanket-challenges the ‘failed rules and institutions’ and promises to ‘throw them out’ or ‘drain the swamp’. He can promise to carry out some of the institutional changes also championed by the mainstream, such as easing excessive regulations, eliminating red tape, and so on. But he would do this to tighten his grip on the system rather than to improve it. Yet the coincidence with some of the goals of the mainstream makes developing effective counter populist policies particularly thorny.    

Policy implications

How can we minimise the risk that a populist will gain power? And, when he is in power, how can we restrain him?

The first line of defence is more responsive mainstream politics that detects justified resentment early on; appropriate redistributive policies; better information (i.e. fight ‘fake news’); and much better public education. There is a need to also address the fundamental mismatch between global economic forces and nation-based legitimacy that underpins the political, institutional, and regulatory systems.

We call for amending the design of some of democracy’s existing commitment devices. These relate to the judiciary, media, central bank, regulators – the elite’s expertise and the experts themselves. The current commitment devices and institutions don’t seem to be fully sufficient nor entirely credible (depending, of course, on the country and its institutional history).

These institutions should be improved immediately by introducing what we call a ‘second generation’ of commitment devices. These are specifically designed to materially improve existing structures through stronger and more credible accountability elements, for both the institutions and the elite. They can reduce the populist’s incentives and ability to introduce measures that would quickly and disproportionally favour him and allow him to enhance his grip over the initial benefits.

We propose taking the wind out of the populist’s sails by:

  • Building long-term (i.e. independent of political cycles) sunset clauses or periodic reviews into important rules and regulations. These would require public reviews and would entice the system to consider the renewal (or not) of elements or the whole mandate of these rules and institutions. Such clauses would lead to periodic public debates that are ultimately crucial for legitimacy and oversight. Review processes could consist of a nonpartisan committee that prepare an institutional ‘performance review’ every 15-20 years. This would be scheduled well in advance – maybe enshrined in law – and take place irrespective of the actual political and economic situation. One could envisage ‘very long-term performance reviews’ of central banks and other regulatory bodies, or of the effectiveness of specific policies, such as debt limits. The underlying idea is that the public should see and feel part of such reviews and the oversight of ‘experts’ work’. This would enable them to internalise the benefits and costs of the rules and institutions over which they do not – and should not – have direct shorter-term oversight. This would both help correct problems and strengthen legitimacy.
  • Employing methods that demonstrably make independent institutions (and the people who lead them) more publicly accountable. For example, generalise term limits and eliminate tenure, or strengthen personal accountability, including professional criminal offences. Also, when institutions are taking on new responsibilities – for example, as central banks have rightly done in addressing the global financial crisis – acknowledge the specific change and announce specific accountability measures alongside it.
  • Focusing on ‘fair process’ versus ‘fair outcome’. Research shows that faced with such a trade-off, people are more concerned about the fairness of the process, and are willing to accept outcomes that are less favourable if they deem the underlying process to have been fair. Fair process also relates to the demonstrated responsibility of individuals, including the elite, for disastrous policy outcomes (for example for the global financial crisis).

These measures alone may not radically change the populist dynamic today – there is no ‘silver bullet’ against populism. But they represent, we believe, material improvements to existing commitment devices and processes, helping to deal with populist threats against the devices themselves and the democracies they support. They improve upon ‘first generation’ commitment devices by building stronger public accountability into independent institutions. As such, they can credibly help reduce the support that today comes from the widespread disappointments with the elite, ‘their’ institutions, and the existing rules of the game, while safeguarding the fundamental institutional underpinnings of democracy. Equally important, they reduce the ability of the populist leader to appropriate and manipulate the short-term benefits of his policies, by forcing all players to take a longer-term view.

Ultimately, however, as in the past, populists today have good chances of prevailing for a very long time if mainstream politicians are unwilling to better understand and act upon the legitimate demands of the people, or to allocate resources to improving the public’s understanding of the long term costs of unsustainable policies. People need to internalise the idea that ultimately, someone always has to pay for the party.

Authors’ note: We are grateful for comments from Charles Wyplosz, Richard Baldwin, Eduardo Levy Yeyati, Martin Wolf and Hector Torres.

References

Case, A and A Deaton (2015), Rising morbidity and mortality in midlife among white non-Hispanic Americans in the 21st century, Princeton University.

Guiso, L, H Herrera, M Morelli and T Sonno (2017), “Demand and supply of populism”, CEPR Working paper 11871.

James, H (2000), The End of Globalisation: Lessons from the Great Depression, Harvard University Press.

James, H (2011), The Creation and Destruction of Value, Harvard University Press.

Piketty, T (2014), Capital in the Twenty-First Century, Harvard University Press.

Rodrik, D (1997), Has Globalisation Gone Too Far?, Institute for International Economics, Washington DC.

Rodrik, D (2017), “Economics of the populist backlash”, VoxEU.org, 3 July.

Stiglitz, J (2015), Rewriting the Rules of the American Economy: An Agenda for Growth and Prosperity, Roosevelt Institute.

Endnotes

[1] Indeed, right-wing populism, including that in the Tump agenda, substitutes free spending with government intervention and price controls. This is similar to the policies of Hungary’s Orban, for example.

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Topics:  Politics and economics

Tags:  populism, time inconsistency, Trump, Brexit, politicians

Deputy Chairman, Banco Hipotecario; former Governor of the Central Bank of Argentina

Programme Director, Institute For Global Affairs, London School of Economics

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